Using Rev. Rul. 82-45 to Pay Shareholder Expenses

A “C” reorganization is a type of corporate acquisition where assets are exchanged for stock. For the transaction to be tax-free, the acquiring company must use its voting stock as the primary consideration for the target’s assets. This is known as the “solely for voting stock” requirement. A problem arises when the acquiring company pays expenses that belong to the shareholders of the target corporation. The IRS can view this payment as improper additional consideration, or “boot,” which can make the entire transaction taxable to the shareholders. To avoid this, IRS guidance provides a safe harbor allowing the target corporation to pay these shareholder expenses without violating the tax-free status of the reorganization.

Identifying Covered Shareholder Expenses

Distinguishing between expenses that are the legal obligation of the target corporation and those that belong to its shareholders is a primary step. Corporate-level expenses are costs the target company incurs for its own benefit in facilitating the reorganization. These are considered valid business costs associated with the transaction and can be paid by the target or, in some cases, assumed by the acquiring corporation without issue.

Corporate expenses include:

• Legal fees for drafting the plan of reorganization
• Accounting fees for preparing and auditing the target’s financial statements
• Appraisal fees required to value the business
• Fees paid to investment bankers for a fairness opinion or for an IRS private letter ruling

Shareholder-level expenses are costs incurred by individual shareholders to protect or advance their personal financial interests. These are not obligations of the corporation itself. If the acquiring corporation were to pay these costs, the payment would be treated as a separate, taxable benefit to the shareholders, violating the rules of a C reorganization.

Common examples of shareholder expenses include a shareholder’s personal legal fees for reviewing the reorganization agreement to understand its impact on their holdings. Fees paid to a personal investment advisor for guidance on whether to approve the deal or for estate planning advice related to the new stock are also shareholder expenses. Similarly, if a dissenting shareholder incurs costs to have their specific block of stock independently appraised, that is their personal expense.

Structuring the Payment Transaction

The IRS-accepted mechanism allows the target corporation to settle its shareholders’ expenses in a way that is respected for tax purposes. The core of the structure is that the target corporation, not the acquiring corporation, must pay these identified shareholder expenses. This payment must occur before the completion of the reorganization, ensuring the funds are sourced from the target’s own assets prior to their transfer.

For tax purposes, the transaction is characterized as a stock redemption. This means the target corporation is treated as buying back a small portion of its shareholders’ stock. The value of the stock deemed to be repurchased is equal to the amount of the shareholder expenses being paid. This characterization prevents the payment from being considered impermissible “boot” from the acquiring corporation.

This structure preserves the tax-free nature of the C reorganization because the “solely for voting stock” requirement applies to the consideration provided by the acquiring corporation. Since the payment for shareholder expenses comes from the target corporation’s assets in the form of a redemption, it is considered a separate transaction that happens just before the reorganization.

The amount of stock redeemed from each shareholder is proportional to the expenses they incurred. This ensures that each shareholder who has their expenses paid is treated as having sold a small fraction of their equity back to the target company. This pre-reorganization redemption allows the subsequent asset-for-stock exchange to proceed without complication.

Required Documentation and Reporting

Proper documentation is required to substantiate the transaction’s form and intent to the IRS. The target corporation’s records must reflect the specific actions taken, beginning with formal resolutions from the board of directors. These resolutions should authorize the payment of the shareholder expenses and state that the payments are a redemption of a portion of the shareholders’ stock.

The plan of reorganization, the master legal document for the transaction, should also reference this action. It should include clauses consistent with the target corporation’s payment of these costs and the redemption treatment. This creates a clear paper trail confirming the transaction’s structure.

The transaction has direct reporting consequences for shareholders on their personal income tax returns. They must report the payment as a sale of a portion of their target company stock. This is reported on Form 8949, Sales and Other Dispositions of Capital Assets, and flows to Schedule D of Form 1040.

The redemption amount affects the shareholder’s calculation of their tax basis in the acquiring corporation’s stock received in the reorganization. The basis of the shares deemed redeemed is used to determine any gain or loss on that portion. The remaining basis is allocated to the new shares received.